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47
DEVELOPING COUNTRIES HAVE BECOMEincreasingly integrated into
globalgoods and financial markets over thelast decade. Their export
volume increased by9 percent per year during the 1990s, up from2
percent during the 1980s. Net long-termcapital flows, even after
declining in 1998,remained almost three times the 1990 level.As
discussed in previous issues of Global Eco-nomic Prospects (World
Bank 1993, 1997,1999a), globalization provides developingcountries
with significant benefits and spurseconomic progress. GDP growth in
develop-ing countries (excluding the transition econo-mies)
averaged 5 percent during the 1990s,compared with 3 percent during
the 1980s.Poverty—the number of people living on lessthan $1 a
day—fell from 29 percent in 1990to an estimated 24 percent in 1996.
But thefinancial crisis of 1997–99 has also shownhow globalization,
and in particular greateropenness to external capital flows, can
exposedeveloping countries to increased volatilityfrom
international financial and goods mar-kets. The poor are especially
vulnerable to thisvolatility.
This chapter reviews the evidence aboutthe impact on poverty of
the external shocksand volatility to which developing countriesare
exposed. It then presents and assesses evi-dence of the impact of
the 1997–98 financialcrisis on poverty in the most affected
EastAsian countries. Finally, it discusses lessonsand policy
conclusions.
The chapter reaches the following con-clusions:
• The financial crisis has underlined howglobalization,
especially financial integra-tion, exposes developing countries to
ex-ternal shocks. These shocks often reducethe gains in poverty
reduction from open-ness and increase poverty significantly inthe
short to medium term. This fact un-derscores the importance of
addressing theissue of volatility in order to maximizethe positive
effects of growth on povertyreduction.
• The countries most affected by the EastAsian crisis illustrate
the asymmetric im-pact of changes in per capita income onpoverty
and the negative effects of vola-tility on growth. Though less
dramaticthan early predictions suggested and veryheterogeneous, the
negative social impactof the East Asian crisis and consequentcrises
in Russia and Brazil has been enor-mous. The increase in
consumption pov-erty has been significant. In addition, thecrisis
has resulted in large and costly re-allocations of people and sharp
declinesin middle-class standards of living. Un-like the situation
in Latin America whereincome inequality increased
significantlyduring crises, in East Asia the effects onincome
distribution have been small andhighly differentiated. The extent
of theseeffects depends on the country’s income
2External Shocks,Financial Crises, and Povertyin Developing
Countries
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48
G L O B A L E C O N O M I C P R O S P E C T S
level and the impact of the crisis on dif-ferent economic
sectors.
• Urban poverty increased in all countries,particularly the
Republic of Korea, wheretotal employment declined and open
un-employment grew more than in othercountries in the region.
Falling real wagesin the urban formal sector affected
mostlyhigh-income groups. In Thailand the im-pact was felt mostly
in rural areas becauseof the large inflows of workers from ur-ban
areas and the relatively small increasesin agricultural prices.
• The crisis demonstrated the flexibility oflabor markets in
developing countries.These markets help absorb the effects ofshocks
through reduced wages and labormobility within and between urban
andrural areas. Thus the decline in total em-ployment in Thailand
and Malaysia waslimited, and employment actually rose inIndonesia.
Labor was reallocated from theformal (urban) sector to other
activities,particularly the informal sector and agri-culture, where
exchange rate depreciationsimproved incentives.
• Even where public spending on safetynets increased
significantly, the impact onpoverty was limited for several
reasons.These included the absence of safety netsbefore the crisis,
response lags, institu-tional problems, and low levels of spend-ing
relative to the scale of poverty. Insome cases evidence suggests
that well-functioning programs were underfundedrelative to the
potential impact of shockson poverty.
• The severity of the crisis in Indonesia isreflected in the
strong responses of house-holds to increase consumption as a
shareof income, adjust their asset holdings, andincrease the share
of staple foods in theirconsumption baskets to cope with theshock.
In the Republic of Korea and Ma-laysia the response of households
was toincrease the savings rate. The composi-tion of consumption
expenditures changedsignificantly. Households spent more, pri-
marily on essential items such as food,fuel, housing, health,
and education.
• Real public expenditures on education andhealth fell in most
countries. The extentto which households were able to adjusttheir
spending to offset this decline var-ied across countries as well as
incomegroups. In Thailand families and govern-ment programs acted
to cushion the im-pact of the crisis in order to avoid declinesin
school enrollment rates or in access tohealth services. In
Indonesia, however, theseverity of the crisis led to significant
de-clines in poor households’ access to botheducation and health
services, particularlyin urban areas. Such setbacks can
haveirreversible effects on human development.
• Any development strategy for stable andsustainable growth must
include bothadequate safety nets and appropriatepolicies and
institutions designed toprevent financial crises and respond
whencrises do occur. Prospects for povertyreduction depend not only
on futuregrowth but also on countries’ capacityto manage volatility
and reduce growthfluctuations.
External shocks andpoverty in developing countries
Discussions of the link between growth andpoverty reduction in
developing countriesimplicitly take the view that long-term
growth(and therefore poverty reduction) is a stableprocess. But as
the financial crisis of 1997–99shows, the process of growth is
neither smoothnor linear and is often subject to sharp
changes(especially major slowdowns and recessions)from a variety of
external or internal shocks(World Bank 1999a). The asymmetric
effectsof income growth on poverty during expan-sions and
downturns, however, imply thatthese changes often have profound,
long-last-ing effects on the poor. A decline in per capitaincome
tends to have a negative effect on pov-erty that is much greater
than the improve-ment generated by an equivalent increase.
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49
While economic crises hurt both poor andrich, the poor have less
leeway to respond tothe crises. If domestic capital markets
wereperfect and the economic downturn tempo-rary, all economic
agents could borrow tosmooth consumption and maintain welfare.But
capital markets are imperfect and seg-mented. Credit or insurance
is typically notavailable to the poor. With few savings andlow or
subsistence incomes, the poor becomeeven more vulnerable to shocks.
Crises andrecessions can result in irreversible negativeeffects on
the poor through their impacts onhealth, schooling, and nutrition.
Volatility ingrowth also tends to create more uncertaintyand risk
for investors. That fact alone tendsto reduce the rate of economic
growth, fur-ther dimming prospects for poverty reduction.Thus the
volatility of the growth process indeveloping countries matters a
great deal forboth immediate and long-term poverty reduc-tion and
income distribution.
In general, the growth process is muchmore volatile in
developing countries thanin industrial countries. Sudden reversals
andother changes in international financial flows
are only one source (albeit an important one)of external shocks
that can lead to crises andrecessions in developing countries.
Fluctua-tions in the terms of trade are another im-portant and
long-standing source, reflectingdeveloping countries’ reliance on
primarycommodity exports and price variability ininternational
markets. Volatility in the termsof trade was almost three times
greater indeveloping countries than in industrial coun-tries during
1961–97 (Pritchett 1998; East-erly, Islam, and Stiglitz 1999)
(figure 2.1).Volatility is particularly significant for theMiddle
East and North Africa, LatinAmerica, and Sub-Saharan Africa.
Usingsimulation models that replicate the range ofobserved economic
fluctuations, Mendoza(1995) finds that disturbances in the termsof
trade account for about one-half of theobserved variability in GDP
and real ex-change rates, and that the share is greaterfor
developing countries than for industrialcountries. Policies to
mitigate and cope withvolatility in growth and the consequent
ef-fects on the poor are therefore essential inall developing
countries.
Figure 2.1 Terms of trade and GDP growth volatility, 1961–97
14
Standard deviations (percent)
3.9
11.3
7.4 8.1
9.7
11.413.1
2.5
5.34.2
2.5
8.6
4.75.6
12
10
8
6
4
2
0Terms of trade Real GDP
High-income
Low- and middle-income
East Asia and Pacific
South Asia
Middle East and North Africa
Latin America and the Caribbean
Sub-Saharan Africa
Note: Unweighted average of countries' standard deviations of
relative distance from Hodrick-Prescott filter trend.Source: World
Bank staff calculations.
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
N D P O V E R T Y
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50
G L O B A L E C O N O M I C P R O S P E C T S
External shocks, long-term growth, andpovertyExternal shocks,
such as variations in theterms of trade, volume of trade, and
externalfinance, are highly correlated with variationsin GDP
growth. They account for a signifi-cant share of the volatility in
developing coun-tries (Easterly, Islam, and Stiglitz
1999).According to Hausmann and Gavin (1995)external shocks explain
30 percent of cross-country variation in GDP volatility in
LatinAmerica. When terms of trade, export vol-umes, external
finance, and interest rateshocks are taken into account,
developingcountries experience more and larger exter-nal shocks
than industrial economies. Theincidence of small and medium-size
shocks isabout the same for both (World Bank 1993).During the 1970s
and 1980s it was not un-usual for developing countries to suffer
unfa-vorable shocks equivalent to 4 percent of GDPor more.
Volatility of growth and other macro-economic variables is also
much larger indeveloping countries than in industrial coun-tries
(Pritchett 1998; Easterly, Islam, andStiglitz 1999). Figure 2.1
shows that volatil-ity in GDP growth is more than twice as highin
developing countries as it is in high-in-come countries of the
Organisation forEconomic Co-operation and Development(OECD). The
volatility of GDP growth ishigher for all developing regions,
except forSouth Asia, and it is more than three timeshigher for the
Middle East and North Af-rica. GDP growth in developing countries
ishighly unstable, with large shifts over timeand low correlation
of per capita growth ratesacross decades (Easterly and others
1993;Pritchett 1998).
Volatility has a negative impact on pov-erty in part because it
reduces long-termgrowth (box 2.1). For instance, a large degreeof
volatility makes “stop and go” policies morelikely, slowing growth
and leading to low-quality policies such as those in
Sub-SaharanAfrica, especially during the 1970s and
1980s.(Guillaumont, Jeanneney, and Brun 1999). Ex-
ternal negative shocks can also interact withsocial conflicts
and weak domestic institutionsfor conflict management to produce
growthcollapses (Rodrik 1998). After controlling forother factors,
Hausmann and Gavin (1995)find that a higher standard deviation of
realGDP is associated with higher rates of pov-erty. They estimate
that if Latin Americancountries had the same GDP volatility as
in-dustrial countries, poverty would decrease by7 percentage
points.
External volatility and fluctuations inpovertyVolatility does
more than simply increase pov-erty. Short-term fluctuations in
income growthalso cause sharp variances in the incidence ofpoverty,
even in the short to medium term.For example, in Venezuela poverty
decreasedby 10 percentage points between 1989 and1991, rose by 20
percentage points between1991 and 1994, then fell again in 1995
androse in 1996 (Lustig and Deutsch 1998).Mexico is another
striking example of this ef-fect, as box 2.2 describes.
Fluctuations in commodity prices may in-duce short- to
medium-term changes in bothgrowth and poverty. During the boom
yearsgrowth is faster and poverty declines, but dur-ing busts,
which are usually more sudden, pov-erty increases. Fluctuations in
commodityprices have a significant, direct impact on per-sonal
incomes and an indirect impact on gov-ernment social expenditures
and GDP. Earlierstudies argued that commodity price boomsdo not
significantly affect real GDP(Cuddington 1988; Gelb and
Associates1988). But more recent empirical work hasshown that
changes in terms of trade havesignificant effects on real output
growth.1 De-clining trends in real commodity prices havea negative
effect on real income growth in thelong term in developing
countries (see chap-ter 4).2 In addition, a slowdown in growth
inthe bust years may become more severe as in-vestments made during
the boom years areoften less productive (Collier and
Gunning1996).
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51
Empirical findings also support the no-tion that economic cycles
have an asymmetriceffect on poverty. They show that a contrac-tion
will have a greater impact on the povertyrate than an expansion of
the same size(Morley 1994; Londoño and Székely 1997a;De Janvry and
Sadoulet 1998).10 It has beenestimated that a 1 percent decline in
per capitaincome during recessionary episodes in LatinAmerica in
the 1980s reduced earlier gains by3.4 percent of per capita income
growth inurban areas and 2.2 percent in rural areas (DeJanvry and
Sadoulet 1998). One explanationfor this phenomenon is that during
recessionsthe unskilled are the first to lose their jobs,because
firms tend to hoard their skilled em-
ployees. As a result, income distribution be-comes more
inequitable, amplifying the effectof declining incomes on poverty
(Agénor1998).
Income poverty and inequalityduring the East Asian crisis
The recent crisis in East Asia has under-lined the risks for
developing countriesof reversals in private capital flows and
thedramatic social impact of the resulting finan-cial crises. The
East Asian crisis had a sub-stantial impact on output and poverty
in1998, although these effects began to lessenin 1999.
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
N D P O V E R T Y
irreversibilities or asymmetric adjustment costs ininvestments
increase uncertainty and lower invest-ment (Pindyck 1991; Aizenman
and Marion1999).7 Second, costs increase because productivefactors
move among sectors in response to morefrequent shifts in price
signals. And third, the riskof inappropriate monetary, fiscal,
trade, and finan-cial policies increases.
Terms-of-trade volatility has been found tohave a negative
effect on long-term growth in de-veloping countries. Commodity
price uncertainty,as measured by the standard deviation of
forecasterrors from some statistical models, reduces growthrates
(Dehn and Gilbert 1999).8 Most empiricalstudies have used direct
volatility of terms of tradeas a proxy for uncertainty and have
found negativeeffects on long-term growth (Mendoza 1994;Hausmann
and Gavin 1995; Guillaumont,Jeanneney, and Brun 1999; Easterly and
Kraay1999).9
The overall evidence also indicates that overthe long run the
dependence of many developingcountries on commodities with volatile
prices has anegative impact on long-term growth and thereforeon
poverty. Dehn and Gilbert (1999) find a signifi-cantly negative
effect of commodity price uncer-tainty on poverty, as measured by
infant mortality.
Box 2.1 Volatility, growth, and poverty
W hen growth proceeds smoothly over timeand income inequality
improves (or at leastdoes not worsen dramatically), poverty
declines asper capita income and real wages rise. The elastic-ity
of poverty, as measured by the headcount in-dex—for example, with
respect to the growth ofper capita income3 —is estimated to be
between–1.5 and –3.5.4 The size of the effect is greater
incountries where income is more evenly distributed(Ravallion
1997).5
To the extent that volatility creates uncer-tainty, it has
negative effects on growth and there-fore on poverty. Recent
empirical evidence supportsthis view and contradicts the early
literature. Usingbalanced panel data for a sample of 92
countriesfor 1960–85, Ramey and Ramey (1995) find that aunit
increase in the standard deviation of innova-tion in GDP
(innovation to GDP growth is used asa measure of uncertainty)
implies a lower GDP percapita growth of 0.2.6 Similarly, from a
growthregression of 130 countries for 1960–95, Easterlyand Kraay
(1999) find that the standard deviationof growth has a strong
negative effect (-0.18) onaverage per capita growth (after
controlling forother variables).
There are three likely explanations for thenegative link between
volatility and growth. First,
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52
G L O B A L E C O N O M I C P R O S P E C T S
The impact of the crisis on povertyIncome poverty almost
invariably increasesduring a crisis. Household surveys conductedin
Latin America during recessionary periodsin the 1980s and 1990s
provide evidence ofthis effect. They show that the incidence
ofpoverty increased during the first year of therecession in 9 out
of 11 cases, and remainedhigher for one or more years after the
reces-sion in 19 out of 21 episodes (Lustig 1999).
Poverty also increased during the first yearof the crisis in the
most affected East Asian
countries (table 2.1). Evidence from Korea il-lustrates the
asymmetric impact of crises onpoverty. During stable growth in
1990–97, theestimated elasticity of the percentage of poorwith
respect to per capita GDP was –3.5(Kakwani and Prescott 1999). But
during thecrisis in 1998 the incidence of poverty in-creased by 123
percent. Real per capita GDPdeclined by 6.7 percent, and
consumption percapita declined by 10.4 percent. In Indonesiaas
well, the rate of increase in poverty wasabout 10 times the rate of
the decline in con-
ing a Gini index of 0.54 in 1989 that remainedunchanged until
1996 (Székely 1998). Total pov-erty rose from its lowest point of
28 percent in1984 to 36 percent in 1989, or from 20.7 to
29.6million poor. Infant and preschool mortality causedby
nutritional deficiencies increased from 1982onward, and educational
indicators for the poordeteriorated (Lustig 1998).
From 1989 to 1994 growth resumed, largelydue to economic and
financial liberalization, realper capita GDP growth averaged 2
percent.Although the total poverty headcount index haddeclined
slightly to 34 percent by 1994, thenumber of poor had increased to
30.7 million(Lustig and Székely 1998; Székely 1999a).According to
Székely (1999b) 86 percent of therise in poverty trends in Mexico
from 1984 to1994 resulted from the increase in inequality,while the
rest was the result of the drop in GDPper capita.
From 1989–94 poverty rose among ruralworkers in the primary
sector and in the southernand southeastern regions. This increase
was theresult of the appreciation of the peso and thedecline in
institutional support for agriculture,including the loss of
subsidies, the collapse ofguaranteed prices for major crops, and
high inter-est rates (Lustig and Székely 1998). The financialcrisis
that hit Mexico at the end of 1994 hadconsiderable repercussions
for growth and total
Box 2.2 External shocks and fluctuationsin poverty in Mexico
Mexico’s experience since the 1970s shows howpoverty declines
during periods of economicgrowth and increases during periods of
crisis andadjustment. External shocks contribute to
thesevariations.
During the 1970s Mexico experienced rela-tively high and
sustained growth. The increase inreal GDP per capita averaged 3.8
percent per year,despite the short-lived financial crisis of 1976
(seebox figure). Income inequality declined: the Giniindex dropped
from 0.58 in 1970 to 0.51 in 1977(Londoño and Székely 1997b). Total
poverty fellsignificantly, dropping from 49 percent in 1968 to34
percent in 1977, or from 23.3 to 21.3 million.Further gains were
realized during the second halfof the decade (reflected in the
numbers for 1977–84), spurred partly by favorable
terms-of-tradeshocks and rising oil production.
In the early 1980s the international environ-ment became
unfavorable for Mexico. Thecountry’s terms of trade declined, and
real interna-tional interest rates increased. The resulting
debtcrisis, the adjustment of the 1980s, and the col-lapse of oil
prices in 1986 resulted in a sharp de-cline in incomes. Between
1982 and 1988 real GDPper capita growth averaged a negative 1.9
percentper year, and real wages fell by 36–46 percent from1983–88.
This decline in incomes contributed to adramatic increase in
poverty (Lustig 1998). In-equality increased sharply in the late
1980s, reach-
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53
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
N D P O V E R T Y
Table 2.1 Growth, poverty rates, and Gini coefficients in East
Asia, 1996–98
Indonesia Malaysia Rep. of Korea Thailand
Real per capita GDP growth (percent)
1997 2.9 5.4 4.5 –1.41998 –15.1 –9.2 –6.7 –10.3
Real per capita consumption growth (percent)1998 –5.5 –12.4
–10.4 –11.6
Headcount poverty indexa National National Urban National1996
11.3 — 9.6 11.41997b 11.0 8.2 8.6 9.81998 16.7 — 19.2 12.9
Gini index1996 0.380 — — 0.4771997 — 0.496 0.290 —1998 0.370 —
0.294 0.481
— Not available.a. Figures for Indonesia are based on
consumption expenditures, with a national poverty line equivalent
to about $1 a day in 1985international purchasing parity (IPP)
dollars; data are from February 1996 and December 1998. Figures for
the Republic of Koreaare based on consumption expenditures, with a
national poverty line equivalent to about $4 a day in 1985 IPP
dollars. Figures forThailand reflect national income poverty,
measured at around $2 a day. Figures for Malaysia reflect income
poverty.b. The 1997 figures for Indonesia and Thailand are
estimates based on precrisis trends in declines in poverty.Source:
Kakwani 1999; Kakwani and Prescott 1999; World Bank staff
calculations.
Box 2.2 (continued)poverty. Real GDP growth declined to a
negative6.2 percent in 1995 and averaged 2.6 percentfrom 1995 to
1998. Total poverty increased dra-matically, rising to 45 percent
in 1996, or 41.7
million (Székely 1999a). Mexico has adjusted tothe crises
primarily through downward flexibilityin real wages rather than
through increases inunemployment.
Changes in poverty, inequality, and per capita GDP in Mexico
15
1968–77
1977–84
1984–89
1989–92
1992–94
1994–96
10
5
0
–5
–10
–15
Percent
Change in total poverty
Average per capita GDP growth
Change in Gini coefficient
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54
G L O B A L E C O N O M I C P R O S P E C T S
sumption per capita—much higher than theusual elasticity during
expansions. While theselosses have been reversed somewhat
since1999, the extent and sustainability of the re-covery remains
to be seen (see chapter 3). Evenreturning to the precrisis level of
poverty, how-ever, is likely to require more time and
incomegrowth.
The severity of the impact of the EastAsian crisis varied across
countries. Differencesin national poverty levels and the
distributionof the income of the poor around these levelsmay
explain some of the variances. For in-stance, in Korea the poverty
line is around $4per day, while in Indonesia it is around $1
perday. If the individuals whose incomes droppedsignificantly are
clustered above the povertyline in Korea and below the poverty line
inIndonesia, the impact of the crisis on povertymay well appear
lower in Indonesia. But otherfactors are also responsible for these
differ-ences.
Korea’s experience was strikingly differ-ent from the others.
Korea had the largest in-crease in open unemployment, a decline in
theeconomically active population, and a largedrop in real wages
that was second only toIndonesia’s. Labor mobility from the
informalsector was also more limited than in othercountries. Korea
is also the most urbanizedEast Asian country, and the negative
impactof recessions has been found to be most dev-astating for poor
urban dwellers (Morley1994; Lustig and Deutsch 1998; De Janvry
andSadoulet 1998). The increase in urban pov-erty in 1998 was huge
in Korea: the headcountindex, based on consumption
expenditures,reached 19.2 percent, an increase of more than10
percentage points.11 The increase was evengreater (15 percentage
points) between the firstquarter of 1997 and the third quarter
of1998—the lowest (7.5 percent) and highestpoints (23 percent),
respectively (Kakwani andPrescott 1999). The incidence of poverty
de-clined to 15.8 percent in the last quarter of1998.
In other countries the increases weresmaller than had been
anticipated, given the
magnitude of the crisis (table 2.1). In Indone-sia the impact of
the crisis on poverty was stillsignificant. Estimates for Malaysia
are notavailable, but welfare declines were wide-spread, presumably
leading to increases inpoverty in both urban areas and
traditionallypoor rural states.
Urban and rural poverty. Urban povertyincreases during crises
owing to a combina-tion of lower real wages, higher unemploy-ment,
and increases in the relative price offoods. The impact of a crisis
on poverty willbe smaller if workers can move easily fromthe formal
sector to other activities, particu-larly agriculture, and if
exchange rate depre-ciations lead to improved incentives
foragriculture. Even under those conditions, how-ever, it is still
likely that urban poverty willincrease.
The relative impact on urban and ruralareas was different in
Indonesia and Thailand.In Indonesia the crisis had a strong urban
bias,even though the percentage changes in pov-erty rates were
similar in urban and rural ar-eas. Poverty in urban areas rose from
9.7percent in 1996 to 15.4 percent in 1998, andin rural areas
climbed from 12.3 percent to17.6 percent. Average per capita
spending inurban areas fell 34 percent in real terms,whereas rural
expenditures fell only 13 per-cent. A survey of expert respondent
views sug-gests that urban areas were, on average, muchharder hit
than rural areas (Poppele, Sumarto,and Pritchett 1999). Of the 20
hardest-hit ar-eas, 14 were urban, while of the 20 that suf-fered
the least impact, 13 were rural. In nearlyevery province, region,
and island, the nega-tive impact of the crisis was consistently
higherfor urban than for rural areas. In Thailand,however, the
impact on poverty was more se-vere in rural areas than in urban.
Poverty ratesrose from 11.8 to 17.2 percent in rural areas,but only
from 1.2 to 1.5 percent in urban set-tings.12 One possible
explanation for the dif-ference in the impact of the crisis on the
twocountries is the higher price incentives for ag-ricultural
production in Indonesia, whichstimulated production.
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55
Regional effects. The impact of the crisisvaried considerably
across subnational regions.In the northern region of Thailand, for
ex-ample, the poverty ratio actually dropped from10.2 percent in
1997 to 9.2 percent in 1998.In the northeastern and southern
regions it rosedramatically, climbing from around 15 per-cent to
23.2 percent and from 8.6 to 14.8percent, respectively. In
Indonesia per capitareal expenditures declined by 42 percent inWest
Java and by 30 percent in Jakarta, re-gions that were better off
before the crisis. Butreal expenditures declined between 10 and
20percent in other regions. These differences aremost likely linked
to the behavior of producerprices. In Indonesia, areas that
produced ex-port crops benefited from the sharp exchangerate
depreciation. This fact combined withseveral reforms (such as clove
marketing) toput more benefits in the hands of farmers.13
Similarly, in Thailand the poor performanceof the southern
region may be linked to thefall in rubber prices during the crisis
period.An important aspect of the crisis in Indonesiais that it
does not appear to have affected poorareas disproportionately.
Rather, the impactvaried in both well-off and poor areas.
The impact on income distributionGiven the significant drop in
GDP normallyassociated with economic crises, poverty rateswill
increase unless there is a massive reduc-tion in inequality. But
income distributiontends to worsen during crises. Inequality
inhousehold incomes or consumption increasedin most of the
countries in Latin America dur-ing crises and recessions in the
1980s (WorldBank 1999a). For 10 recession episodes forwhich data
are available in Latin America,inequality rose in 6 cases during
the recessionyear (Lustig 1999). In Argentina the Gini co-efficient
for the greater Buenos Aires area in-creased from 0.44 to 0.53
during the recessionof 1989. Inequality was higher after the
re-cession than it had been before in 15 out of22 episodes. In
Chile the Gini coefficient ontotal household incomes is estimated
to haveincreased from 0.52 in 1979 to 0.55 in 1984
because of the impact of high open unemploy-ment and (by some
measures) deep real wagecuts. However, the Gini coefficient in
Chilehad declined to 0.53 by 1988 (Riveros 1994).
In Brazil income inequality increased, de-spite a successful
defense of real wages in theformal sector and little increase in
open un-employment, in part because of inflation anddeclining
incomes in the informal and agri-cultural sectors (Fox, Amadeo, and
Camargo1994). In Argentina average real wages oscil-lated wildly
with episodes of inflation duringthe 1980s, though unemployment was
nothigh. However, the gap in earnings betweenthe top and bottom
deciles of income earnersin Buenos Aires widened steadily from
1980through 1988 as younger adults increasinglyentered the informal
sector (Riveros andSanchez 1994).
Analyses of the effects of crises on incomedistribution
suggested that the impact differedin middle- and low-income
countries(Bourguignon, de Melo, and Suwa 1991). Dur-ing most
economic crises and subsequent struc-tural adjustments in
middle-income countries,income distribution worsens because wage
cutsand layoffs in the formal sector tend to be bi-ased toward
unskilled workers. The impactof crises on inequality in low-income
coun-tries is more difficult to predict. Wage and em-ployment
losses in the urban formal sectoraffect workers with relatively
high incomes,and the rise in food prices hurts the urban poor.But
the rural areas where most of the poorlive tend to gain because of
currency depre-ciation and higher prices for agriculturalgoods.
Bourguignon, de Melo, and Suwa(1991, 359) find, from simulations,
that “inthe standard adjustment package, inequalityincreased
significantly for the Latin Americanarchetype but decreased
significantly for theAfrican archetype.” A major reason for
thisdifference is that there are few formal sectorwage earners in
the bottom half of the incomedistribution ladder in very poor
countries—for instance, those in much of Sub-SaharanAfrica. Because
crises hit the formal sectorhardest, the poor are less affected. In
Latin
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
N D P O V E R T Y
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G L O B A L E C O N O M I C P R O S P E C T S
America, however, where formal sector work-ers come from all
income brackets, poor peopleare hit more directly in a crisis.
Compared with Latin America in the1980s, the distributional
impact of the EastAsian crisis was limited for high-income
coun-tries (Korea), upper-middle-income countries(Malaysia), and
lower-middle-income coun-tries (Indonesia and Thailand). Changes
inoverall inequality, as measured by the Gini co-efficient, were
minor between 1996 and 1998(table 2.1).14 In Thailand there may
have beenweak redistribution from middle- to high-in-come groups
(Kakwani 1999). But early stud-ies for Korea and Thailand suggest
that thoseat the bottom of the income distribution lad-der—the
“ultrapoor”—were hit harder thanothers with incomes below the
poverty line(Kakwani 1999; Kakwani and Prescott 1999).The evidence
is more mixed for Indonesia(Poppele, Sumarto, and Pritchett
1999).
Labor incomesTo a large extent the impact of the crisis
onconsumption poverty reflects changes in thereal incomes of
households. The channelsthrough which the impact of a crisis
reacheshouseholds can be traced to the sources ofhousehold
income—that is, wages, returns onassets, profits from
self-employment, andtransfers (Ferreira, Prennushi, and
Ravallion1999). These sources tend to vary with house-hold income
level—for example, poor house-holds tend to depend on
self-employmentincomes and transfers, whereas the rich receivemuch
of their income from assets. For thisreason, changes in the overall
composition ofnational income can move households up ordown the
distribution ladder.
Labor markets have the most profoundeffects on poverty, however.
Labor demandshocks hurt households by lowering realwages,
increasing unemployment, and reduc-ing self-employment earnings.
While reducedlabor demand almost always raises the inci-dence of
poverty, different kinds of labor de-mand–shocks have different
effects on incomeinequality. In a recession, real wages fall.
Households at the low end of the distributionladder in
developing countries are affected theleast, because they receive
little or no wageincome. But labor demand shocks have astrong
impact on those formal sector workerswith the lowest skills, who
are more likely tolose their jobs than their more skilled
coun-terparts.15 They then either become unem-ployed or move to the
informal sector, wheretheir earnings are likely to be lower. As a
re-sult households at the middle to lower-middlerange of the income
distribution ladder arepushed further down, swelling the numbersof
households with low incomes.
The crises in East Asia followed a patternsimilar to those seen
earlier in other countriesfaced with sharp reversals of external
capitalflows. A comparative analysis of the impactof similar crises
on labor markets offers thefollowing conclusions (Fallon and
Lucas1999):
• Wages fall sharply during the crisis or inensuing years,
usually by more than theGDP. In 22 recessionary episodes in
LatinAmerica during the 1980s and 1990s, realwages fell in 16 cases
during the year ofrecession, and in 18 cases remained lowerthan
precrisis levels after two years (Lustig1999). This wage drop was
also a strik-ing feature of the East Asian crisis.
• Total employment growth drops in thecrisis year, but usually
by less than thedecline in GDP growth.
• Employment in manufacturing is alwaysadversely affected,
though less spectacu-larly than are wages.
• The effects on agricultural employmentare more muted. In some
cases (for ex-ample, Indonesia in 1998 and Turkey in1994),
employment increased despite anabsolute decline in GDP.
• Rising unemployment is an important fea-ture of many crises.
In Latin America un-employment increased during the year
ofrecession in 24 of 31 episodes and re-mained higher in 24 cases
two years intothe recession (Lustig 1999). The most sig-
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57
nificant increases were in Argentina in1995 (6 percentage
points) and Chile in1982 (11 percentage points).
Experience thus far in East Asia broadlysupports these
conclusions. Real wage growthdropped sharply in 1998 and became
nega-tive in all affected countries (table 2.2). Indo-nesia saw
particularly spectacular wagedeclines that were broadly similar
across sec-tors. Although wage cuts can moderate theimpact of a
recession on employment, duringthe East Asian crisis
nonagricultural employ-ment fell in all countries. Only in
Indonesia,where agricultural employment increased con-siderably,
did overall employment rise. Theconstruction sector was the most
affected, witha dramatic drop in employment of 15 to 35percent, but
manufacturing employment alsofell significantly. With the exception
of Ko-rea, however, falls in employment in 1998 werenot large
despite substantial decreases in GDP.(Korea saw a large decline in
employment aswell as in real wages.) The inactive popula-tion
increased by 9 percent between the sec-ond quarter of 1997 and the
fourth quarter
of 1998, with women representing three-fourths of the increase.
In Thailand 18.5 per-cent of the overall decline in per capita
incomewas the result of wage cuts, whereas only 2.7percent was
attributable to higher unemploy-ment (Kakwani 1998).
Labor force mobility. To some degree, theimpact of the crisis on
employment was less-ened by the mobility available to
individualworkers within and between the urban andrural sectors. In
the first year of a crisis sig-nificant real exchange rate
depreciation usu-ally results that can raise the price of
tradablegoods relative to those of nontradables, withimportant
implications for real household in-comes and poverty. Crises hit
the urban for-mal sector first and, as noted above, can leadto a
reallocation of labor from the urban tothe rural sector. But in the
absence of any in-centive to increase agricultural production,
thisreallocation of human resources may do littlemore than raise
rural poverty instead of ur-ban poverty. In principle exchange rate
depre-ciation can supply the needed incentive. In theabsence of
intervention in domestic markets,it raises the price of export
crops relative to
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
N D P O V E R T Y
Table 2.2 Employment and real wages in East Asia during the
crisis(percentage change)
Indonesia Malaysia Rep. of Korea Thailand1997 1998 1997 1998
1997 1998 1997 1998
Employment, totala 1.8 2.6 4.6 –2.7 1.4 –5.8 1.8
–3.0Agricultural –4.7 13.3 –0.6 –5.3 –3.4 0.0 1.3
–1.8Nonagricultural 6.8 –4.7 5.8 –2.2 2.4 –6.5 2.2
–3.9Manufacturing 4.1 –9.8 7.6 –2.9 –4.3 –13.1 –0.1
–1.9Construction 10.6 –15.9 8.9 –13.4 1.7 –26.4 –5.6 –33.6
Real consumption wage, totalb 8.6 –41.0 — — — — 5.7
–1.5Agricultural 4.1 –35.0 — — — — 10.0 –8.9Nonagricultural 9.9c
–42.0c — — 2.6 –10.0 5.0 –0.5Manufacturing 11.1 –44.0 6.0 –2.4 0.7
–10.6 7.1 –4.5Construction 8.5 –42.0 — — 3.3 –14.7 3.8 –2.2
— Not available.a. Figures for the Republic of Korea are from Q4
to Q4. Figures for Thailand are calculations by World Bank staff
based on theLabor Force Survey, National Statistical Office, and
surveys of national employment for February and August.b. Figures
for Indonesia are for August 1998 and average 1997. Figures for the
Republic of Korea are seasonally adjusted. Figuresfor Thailand are
calculations by World Bank staff based on the Labor Force Survey,
National Statistical Office, and average wages(excluding fringe
benefits) of February and August surveys.c. Urban areas.Source:
Employment – Islam and others 1999; Mansor and others 1999; Shin
1999; World Bank staff calculations. Real wages –Datastream; Islam
and others 1999.
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58
G L O B A L E C O N O M I C P R O S P E C T S
the prices of other commodities. In rural ar-eas higher food
prices spur agricultural pro-duction, and the impact on poverty
will dependon the strength of the link between agricul-tural
production and the poor. Insofar as smallfarmers benefit, the link
to poverty may bestrong. But insofar as export crop productionis
concentrated among large farmers, the im-pact depends on whether
the demand for ag-ricultural workers increases sufficiently
tooffset the growing supply of rural labor.
In Indonesia around 2.5 million workers,or 3 percent of the
total work force, were dis-placed by the crisis in the first year.
Job lossesoccurred in all sectors of the economy exceptagriculture
and the small transportation andcommunication sectors. The
manufacturingsector accounted for nearly half of all joblosses,
followed by construction. Losses weresomewhat smaller in the
mining, trade, andservice sectors. About three-quarters of thejobs
lost in these sectors were in rural areas.In urban areas many
workers displaced fromthe manufacturing and construction sectors
en-tered the trade and other service sectors. Ur-ban employment
actually grew from 29.4 to30.3 million persons (Islam and others
1999).In contrast, displaced workers in rural areashad fewer
opportunities, and many wereforced to take up agricultural
employment.16
Agricultural employment rose in Indonesia in1998 despite severe
drought conditions insome areas. While labor reallocation
wasgreater in rural than in urban areas, the in-crease in poverty
was greater in urban areasdue to the incidence (although limited)
ofunemployment, the greater decline in wagesin manufacturing and
construction, and thefall in informal sector incomes as more
crowd-ing occurred.
In Thailand the crisis greatly affected theflow of labor between
urban and rural areas.The principal reason for the increase in
pov-erty in the rural areas, particularly in the north-east, was
the integration of the rural andBangkok labor markets through
migration.The crisis dramatically curtailed the regularflow of
workers to Bangkok, particularly from
the northeast, increasing the rural labor sup-ply beyond what it
would otherwise have been.The number of recent migrants to
Bangkok(those arriving in the past year) had dropped50 percent by
February 1998 from the levelsof a year earlier, and the share
coming fromthe northeast fell from 68 percent to 38 per-cent. The
types of workers who moved toBangkok also changed dramatically. In
Feb-ruary 1997, 25 percent of all migrants toBangkok had less than
an elementary educa-tion and only 28 percent had a secondary
orhigher education. One year later these num-bers were 13.5 percent
and over 41 percentrespectively. These results indicate that
un-skilled workers stopped going to Bangkok,whereas those with
higher skills continued tomigrate. In Indonesia there is evidence
of sig-nificant return urban-rural migration. Around1 million urban
workers entered the agricul-tural sector, although their families
stayed inurban areas.
Other labor market developments. Laborforce mobility and fewer
work opportunitieswere accompanied by other labor market
de-velopments. First, hours worked per week fellas workers crowded
into the urban informaland rural sectors. In Indonesia, the share
ofemployees working fewer than 35 hours perweek increased from 30.6
percent in 1997 to34.3 percent in 1998, with the trend
towardshorter hours greater in urban areas. In Ko-rea, average
hours dropped from 46.6 hoursper week to 46.0, with the shorter
workingweek most prevalent in manufacturing. Sec-ond, the
composition of employment changed,shifting away from wage
employment. In In-donesia, the proportion of workers outsidewage
employment rose from 55.1 percent in1997 to 58.9 percent in 1998.
Third, in Ko-rea at least, the number of highly skilled work-ers
rose as a share of employment. Forinstance, the share of managers
and profes-sionals had increased from 17.1 percent at theend of
1997 to 21.1 percent by the end ofMarch 1999.
With the exception of Korea, where theagricultural sector is
much smaller than in the
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59
other East Asian economies and total employ-ment decreased
substantially, the increase inunemployment in 1998 was not
particularlylarge (figure 2.2). In Korea, the unemploymentrate
peaked at 8.7 percent in February 1999,an increase of 6.4
percentage points over thelow of 2.3 percent in June 1997.17 But
the ratehad fallen to 6.2 percent by June of the sameyear.
Underutilization of labor was greater thanthe data on unemployment
indicated, as for-mal sector working hours fell in all
countriesduring the recession. In Thailand total unem-ployment
increased by 2.5 percentage pointsduring the crisis and remained
high during thefirst half of 1999. In Malaysia open unem-ployment
increased by much less than ex-pected, rising from 2.7 to 3.2
percent. It peakedat 4.5 percent in March 1999, both
becauseproductivity-based wages allowed real wagecuts and because
migrant workers employedin construction, the hardest-hit sector,
left thecountry.
It is still too early to assess how the crisisaffected the
incidence of unemployment in dif-ferent groups. In Korea
unemployment seemsto have risen more among men than amongwomen,
possibly because the female partici-
pation rate dropped as the crisis intensified.The number of
regular female employees fellby around 20 percent between October
1997and October 1998. Layoffs in the formal sec-tor initially
raised unemployment among olderage groups, but unemployment among
theyoung is undoubtedly rising in the absence ofjob creation. The
less educated and less skilledwere the hardest hit. For those with
no highschool diploma, unemployment increased from1.2 percent in
June 1997 to 5.8 percent in June1998, and for those with high
school diplo-mas it climbed from 2.8 percent to 8.4 per-cent (Na
and Moon 1999).
Government safety nets andpoverty alleviationRaising transfers
can offset increases in incomepoverty caused by declines in labor
demand.For this reason some governments have triedto strengthen
safety nets, or income transferprograms. The success of these
efforts dependson several factors: the existence of
well-func-tioning programs, the institutional and deliv-ery
capacity of central and local agencies, thesize of budget
allocations and the severity offiscal constraints, and the
political economy
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
N D P O V E R T Y
Figure 2.2 Unemployment in East Asia during the crisis
8
Percent
7
6
5
4
3
2
1
0
1.6
4.1
Thailand
2.6
7.4
Republic of Korea
4.75.5
Indonesia
2.73.2
Malaysia
Note: Figures for the Republic of Korea are for urban
unemployment, and those for 1998 are from the second half of the
year. Figures for Indonesia are from August of each year. Figures
for Thailand reflect unemployment as a percentage of the current
labor force and are an average of February and August figures for
each year.Source: Shin 1999; Islam and others 1999; Malaysian Labor
Force Survey; World Bank 1999d.
1997
1998
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60
G L O B A L E C O N O M I C P R O S P E C T S
affecting redistributive and poverty alleviationefforts.
It is still too early to assess fully the im-pact of efforts to
provide safety nets duringthe crisis. However, the available
evidencesuggests that even though levels of publicspending on
safety nets increased significantly,the impact on poverty was
limited. An analy-sis of country experiences suggests that
thislimited effect can be traced to a range of fac-tors, including
response lags, institutionalproblems, and low levels of spending
relativeto the scale of poverty.
The governments of East Asia generallydid increase the budgetary
share of incometransfers significantly in response to the cri-sis.
However, spending as a share of nationalincome remains low by
international standardsand has increased in only two
countries(Klugman 1999) (figure 2.3). Korea had thelargest
proportionate increase, with spendingon safety nets rising from
zero to 5 percent ofthe budget, followed by Indonesia, where
thebudgetary share rose from zero to 3.6 percent.In Malaysia the
safety net as a share of gov-ernment expenditure held steady at a
low 0.16
Figure 2.3 Poverty and spending on social safety nets in East
Asia, 1996–98
2.5
2.0
1.5
1.0
0.5
0.0
24
19
14
9
4
-11996
Percent Percent
Percent Percent Percent Percent
Percent Percent
Indonesia
1998 1996 1998
1996 1998 1996 1998
6 20
15
10
5
5
4
3
2
1
0
Republicof Korea
1.0 9
8
7
6
5
4
3
2
1
0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
Malaysia
3.0
2.5
2.0
1.5
1.0
0.5
0.0
14
12
10
8
6
13
11
9
7
5
Thailand
Expenditures (left axis) Headcount index (right axis)
Source: World Bank staff estimates.
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61
percent during the period. Spending on safetynets as a share of
national income rose quitesteeply in Korea and Indonesia, though
expen-ditures were low to begin with. These trendscontrast with
those observed in Europe andCentral Asia, where expenditures on
safety netsdeclined significantly across all countries(Milanovic
1998).
Korea. The central response of the Ko-rean government was to
introduce a publicworks scheme that grew enormously duringthe
crisis period, rising to 200,000 participantsin January 1999 and
410,000 in mid-1999.The scheme paid wages lower than the
pre-vailing wage for unskilled workers in order toattract only
those truly in need of employment.The scheme also was supposed to
guarantee ajob for all who wanted one, although therewas
significant excess demand for the num-ber of places available by
late 1998. (Therewere 700,000 applicants in January 1999.)
The budgetary share of safety nets in Ko-rea did increase during
the crisis, but recentanalyses have shown that the incremental
bud-get and program coverage in 1998 were inad-equate to meet the
country’s needs. Safety netprograms covered only 7 percent of the
“new”poor in 1998. Overall coverage of the poor(old and new)
dropped from almost one-thirdprior to the crisis to about 17
percent in 1998,and it is expected to fall further (to 16 per-cent)
during 1999 (Subbarao 1999).18 Thereis evidence that women have
been excludedfrom public works, and there are accusationsof
mismanagement and a lack of useful out-put. Still, what has been
done reflects twoimportant lessons: keeping the wage
sharehigh—around 70 percent—creates more jobsper won spent; and
diversifying the jobs menuto include more than engineering works
(forinstance, work in libraries) increases job op-portunities. Some
other East Asian govern-ments are just beginning to learn these
lessons.
Thailand. In Thailand government safetynets did not fill much of
the gap left by infor-mal transfers at least until 1998. Overall
safetynet expenditures increased during the crisis,especially
during 1999, though some income
transfers appear to have been procyclical—thatis, contracting
with the economy rather thanexpanding. This situation was the
result of con-flicting pressures and the government’s reluc-tance
to undermine the informal safety net.For example, social pensions
and family al-lowances in rural Thailand appear to be welltargeted,
but they are underfunded (Prescott1999). The benefit value is less
than one-thirdof subsistence requirements and reaches onlyone-third
of the target group. Further, the realvalue of the benefit
transfers in Thailand hasbeen falling over time because of the
govern-ment’s failure to adjust them for inflation. Oneprogram that
expanded in response to the cri-sis in Thailand was the Ministry of
Health’sprogram providing low-income groups withaccess to public
health services. Under thestimulus package, job creation for the
poorunemployed was a priority.
Indonesia. The major new safety net pro-grams introduced in
Indonesia as a result ofthe crisis were a rice distribution
scheme(known as OPK) and a public works scheme(Padat Karya). Early
evidence suggests thattheir coverage of the poor and their impacton
poverty have been limited. The OPK makes10 kilograms of
medium-grade rice availableto selected households every month at
subsi-dized prices. On average, this amount repre-sents less than
30 percent of the income of asingle individual living at the
poverty line andless than 6 percent of the income of a house-hold
of five. OPK uses an indicator-based tar-geting system with minimum
standards forfood intake, housing, clothing, and
medicalexpenditures.
Evaluations of these programs suggest thatjust over one-third of
all poor households haveparticipated in the Indonesian public
worksprogram. The leakage of benefits to the non-poor has been
significant, however. In Jakarta,9 percent of the poor households
worked onceon the scheme, compared with 30 percent ofthe middle
income households. In Medan only5 out of over 400 poor households
partici-pated in Padat Karya, because the contractorused his own
workers.
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
N D P O V E R T Y
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62
G L O B A L E C O N O M I C P R O S P E C T S
Other experiences. Declines in publicspending and a failure to
reach the poor haveundermined safety net programs in Russia
andCentral Asia. Russia provides a striking ex-ample of the failure
of safety net programs toalleviate poverty. Spending on social
assistancedeclined throughout the transition, amount-ing to only 4
percent of the poverty gap in1997, while the incidence of poverty
more thantripled. This shortfall can be attributed in partto the
concurrent collapse of the tax revenuesystem (UNICEF 1998), but it
is also the re-sult of an apparent failure to identify andimplement
programs that reach the poorand that have sufficient political and
electoralsupport.
In addition, the safety net in Russia is notwell targeted. Most
Russian households re-ceive some type of government transfer, but
asignificant proportion of the very poor (al-most 3 out of 10) and
of the poor (1 out of 5)receive no benefits. At the same time
almostfour out of five households that are not poordo receive
public transfers (Foley andKlugman 1997). Even so, the decline in
bud-get allocations for public transfers, coupledwith widespread
delays in payments, hasmeant a clear weakening in the impact
oftransfers on poverty over time. The reductionin the poverty
headcount attributable to pub-lic transfers fell from 29 to 24
percentagepoints between 1994 and 1996 (Klugman andKolev 1999).
Beyond current income effectsof the East Asian crisis
Standard poverty measures based on in-comes and household
expenditures captureonly some aspects of the social impact
anddistress crises cause. Households use variousmechanisms to cope
with shocks from crises.These responses may help mitigate the
imme-diate impact, but they may also have impor-tant implications
for future poverty andvulnerability to shocks. Crises also create
pres-sures on governments for fiscal austerity whichmay exacerbate
the negative social impacts,
but appropriate fiscal policy may also help al-leviate some of
these effects.
Behavioral responses and assetaccumulation during
crisesFinancial crises affect not only current incomesbut also the
value of household assets. Infla-tion, for instance, has been found
to be one ofthe most significant determining factors ofpoverty
(Datt and Ravallion 1997; Agénor1998; Easterly and Fischer 1999).
It erodesthe value of fixed-denomination assets suchas money, which
is the primary asset of thepoor and near-poor. These groups have
littlescope for hedging.
As they do to labor market shocks, house-holds respond in
variety of ways to the in-come, wealth, and relative price effects
of acrisis. These responses include consumptionsmoothing, changing
the composition of theconsumption basket, selling existing
physicalassets, and acquiring fewer new ones.
Savings behavior during the East Asiancrisis. Changes in
household savings patternsduring the crisis varied significantly
acrosscountries. The savings rate changed little inThailand. In
Indonesia the savings rate de-clined sharply, falling about 8
percentagepoints of GDP (figure 2.4). The savings re-sponse helped
reduce the impact of the crisis
Figure 2.4 Change in gross domesticsavings, 1997–98
6
Percentage of GDP
4
2
0
–2
–4
–6
–8
ThailandIndonesiaMalaysia Republic
of Korea
Source: World Bank staff calculations.
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63
on consumption among poor households, butthe reductions in
capital accumulation reflectthe severity of the crisis.
In Korea and Malaysia the decline in percapita consumption was
much greater than thedecline in per capita GDP between 1997 and1998
(table 2.1). In Korea the savings rate rose,but the increase
reflects primarily the behav-ior of high-income groups.19 Total
gross do-mestic savings increased by more than 4percentage points
of GDP. Private savings in-creased at an even greater rate,
especially inlight of the increase in the government
deficit.Savings declined from 16.3 percent to 11.6percent among the
20 percent of householdswith the lowest incomes, however
(Kakwaniand Prescott 1999). Because of the decline inthe
consumption ratio and the varied effectson income distribution in
Korea, the incidenceof income poverty increased much less
thanpoverty based on consumption (discussedabove, table 2.1),
rising from 2.6 percent in1997 to 7.3 percent in 1998.
Changes in asset holdings and the com-position of the
consumption basket. Informa-tion about changes in asset holdings in
thecrisis countries is limited. Some evidence is
available for Indonesia showing that peoplein the most affected
regions, such as Java, soldsome of their assets (Poppele, Sumarto,
andPritchett 1999). But more complete evidenceis available on
changes in the consumptionbasket. Rising food prices are especially
im-portant in determining changes in the compo-sition of
consumption, because higher pricesreduce the real incomes of
households withrelatively high food expenditures—mainly theurban
poor. Food prices rose relative to othercommodities in all
countries after the crisis(figure 2.5). However, the effect was
smallexcept in Indonesia, where relative food pricesrose by 40
percent between mid-1997 and mid-1998. The effect is reflected in
the dramaticchanges in the composition of expenditures:the share of
staple foods increased from 23.1to 31.7 percent, while that of
meats and non-food items (including health and education)declined
(Poppele, Sumarto, and Pritchett1999).
Between 1996 and 1998 households inThailand, particularly those
with low incomes,increased essential real expenditures such asfood,
fuel, medical supplies, shelter, and edu-cation but reduced other
expenditures (World
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
N D P O V E R T Y
Figure 2.5 Relative price of foods during the crisisIndex of
food prices relative to total consumer price index (1997=100)
140
130
120
110
100
90
80Q3
1999Q2
1999Q1
1999Q4
1998Q3
1998Q2
1998Q1
1998Q4
1997Q3
1997Q2
1997Q1
1997Q4
1996Q3
1996Q2
1996Q1
1996Q4
1995Q3
1995Q2
1995Q1
1995
Source: Datastream.
Indonesia
Malaysia
Thailand
Republic of Korea
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64
G L O B A L E C O N O M I C P R O S P E C T S
Bank 1999d). Korean households had a dif-ferent response. The
shares of food, clothing,and furniture in total expenditures
actually de-clined, but spending for education and healthincreased
(Kakwani and Prescott 1999).
Fiscal austerity and household demandfor health and educationThe
East Asian economies eventually widenedtheir fiscal deficit targets
to counter the re-cessionary effects of the crisis. Yet real
gov-ernment consumption expenditures fell in allcountries except
Thailand in 1998. In Indone-sia the decline outpaced the fall in
GDP. As aproportion of GDP, health expenditures re-mained
relatively unchanged during the last halfof the 1990s, including
the first year of the re-cession (table 2.3). Education
expenditures fellrelative to GDP when the crisis struck in
Ma-laysia and Korea, but rose in Thailand.
Changes in public spending on educationand health affects both
the availability of theseservices and, because the services may
becomemore expensive, households’ decisions to usethem. The full
impact of the crisis on publicservices remains unclear because of
the differ-ences in fiscal policy responses and the lim-ited
information available on changes in thecomposition of public
expenditures. Some dataare available for Korea, Thailand, and
Indo-nesia, however.
Korea. In 1998 households spent less onitems such as clothing
and recreation butmaintained spending levels on education
andhealth. The rates of decline for education (9percent) and health
(14 percent) expenditureswere lower than the decline in total
expendi-tures (18 percent) (Kakwani and Prescott1999).
Thailand. Families and government pro-grams acted to cushion the
impact of the cri-sis on education and health (World Bank1999c). So
far the crisis has not had a nega-tive effect on education. In the
year followingthe onset of the crisis, total gross enrollmentsin
primary and general upper secondaryschools increased from 74.8
percent to 75.5percent. The dropout ratio—children of schoolage not
attending school—continued to declinebetween 1996 and 1998.
Families employeda variety of strategies to keep their children
inschool. First, households spent less on nones-sential consumables
such as alcohol, tobacco,clothing, footwear, household goods,
transpor-tation, and communications. Second, familiesused savings
or borrowed from informalsources to finance education, so that
realspending on education rose for both the poorand nonpoor. Third,
for nontertiary educationfamilies shifted their children from
private topublic schools as the relative cost of attend-ing private
schools increased. Finally, families
Table 2.3 Public spending on health and education(percentage of
GDP)
1994–95 1995–96 1996–97 1997–98 1998–99
HealthIndonesia 0.7 0.6 0.6 0.6 0.6Korea, Rep. of 0.5 0.5 0.5
0.6 0.6Malaysia 1.3 1.3 1.4 1.4 1.3Thailand 1.1 1.1 1.2 1.4 1.3
EducationIndonesia 1.4 1.2 1.4 0.7 0.7Korea, Rep. of 5.0 5.0 5.1
4.3 4.0Malaysia 5.3 4.9 4.0 4.7 4.3Thailand 3.4 3.3 3.1 3.4 4.2
Note: Public expenditures include national and local
government.Source: Baptist 1999.
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65
made greater use of government scholarshipand loan programs.
Government policies and programs alsosupported continued
investment in education.Real expenditures on education remained
con-stant between 1997 and 1998, and the shareof education
increased in total expenditures.A number of programs and measures
were in-troduced to protect educational opportunitiesfor the
vulnerable. These included allowingparents to pay tuition fees in
installments, per-mitting schools to waive tuition fees on a
case-by-case basis, introducing scholarships,expanding the
education loan program, en-couraging private schools to extend
paymentdeadlines, and providing vouchers to privateschool children
(in the Bangkok metropolitanarea). These achievements are
remarkable butmay be difficult to sustain, as the recoveryremains
weak and the effects of the crisis con-tinue to be severe.
Households, particularlythe poor, may be less able to shift more
re-sources to education and sustain higher debts.
There is also no evidence of a negativeeffect on national health
outcomes. For in-stance, the number of reported cases of
mal-nutrition continued on a downward trend in1998. Households’
real expenditures on bothprivate and public health services
declined sig-nificantly. Out-of-pocket real expenditures onmedical
and institutional care were 36 percentlower in 1998 than in 1996,
whereas spend-ing on self-medication increased by 12 per-cent. The
decline in expenditures was lowerfor the poor, who undoubtedly
tried to sus-tain essential health expenditures and who
alsobenefited from public health services. Thegovernment maintained
its level of investmentin health, with real expenditures on
healthdown by 5 percent in 1998 from 1997 levelsbut still 11
percent higher than they were in1996. The decline mainly affected
investmentexpenditures. The government enlarged itshealth safety
net by increasing the coverageof public health insurance. Use of
public healthservices increased between 1996 and 1998,with the
number of outpatient visits rising by22 percent.
Indonesia. The severity of the shock andfalling living standards
led to a decline inschool enrollment rates (Frankenberg, Tho-mas,
and Beegle 1999). This decline was muchlarger at the secondary
level—some 4 to 5 per-centage points of enrollment rates20 —than
atthe primary level. Consistent with the urbanbias in the effects
of the crisis on incomes, thedecline in school enrollment was
largest in ur-ban areas, particularly Jakarta. The popula-tion with
the lowest per capita expenditureshad the highest rates of decline
in school en-rollment: more than 5 percentage points forthe 13–19
age group for the lowest twoquartiles, and more than 6 percentage
pointsfor the 7–12 age group for the lowest quartile.Because they
had to increase food expendi-tures during the crisis, families had
a difficulttime maintaining expenditures on education,and its share
in total expenditures declinedfrom 3.5 percent in 1997 to 2.9
percent in1998.
The effects of the crisis on health werecomplex and
heterogeneous but clearly nega-tive. The share of household
expenditures onhealth declined from 1.4 percent in 1997 to 1percent
in 1998. The use of public health ser-vices following the crisis
declined by 1.8 per-centage points (from 7.2 to 5.4 percent)
foradults and by more than 7.1 percentage pointsfor children. The
proportion of visits made totraditional practitioners nearly
doubled. In1997 nearly one-half (46.7 percent) of all chil-dren
under the age of five had visited a com-munity health post in the
month before thesurvey, but this rate declined to about one-quarter
(27.7 percent) in 1998.
Fostering sustained growth andreducing the social costs
ofvolatility and crises
Financial crises have large social costs andtend to retard or
even reverse gains in pov-erty reduction for significant periods of
time,even in the most successful countries. Policiesand
institutions that reduce these risks, helpprevent financial crises,
and minimize their ef-
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
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G L O B A L E C O N O M I C P R O S P E C T S
fects when they do occur can help smooth thegrowth process and
maximize the positive ef-fects of growth on poverty alleviation
(WorldBank 1999a; Ferreira, Prennushi, andRavallion 1999; Lustig
1999). Realizing thelong-term benefits of openness, reducing
pov-erty over the long run and avoiding tempo-rary setbacks in
poverty reduction requiresappropriate national and international
poli-cies. These policies must minimize the risksof external
volatility and improve the capac-ity to manage it at both levels.
Safety nets arepart of any broad-based strategy for limitingthe
impact of crises and negative shocks onpoverty.
Preventing crises. Avoiding crises is clearlythe most effective
way to achieve stable andsustainable growth. Macroeconomic and
fi-nancial policies that avoid profligate fiscal andmonetary
policies, seriously overvalued ex-change rates, and unsustainable
current ac-count deficits are necessary to prevent crises(World
Bank 1999a; Lustig 1999). More flex-ible exchange rates, greater
reliance on fiscalpolicy, and better and tighter domestic
finan-cial regulation are often needed to reduce ex-cessive capital
inflows and domestic lendingbooms (World Bank 1999a). Financial
sectorliberalization must proceed carefully and instep with the
capacity of countries to enforcetighter regulation and supervision.
Efforts toimprove prudential safeguards and bankingoperations need
to be accelerated in most de-veloping countries. The opening of the
capi-tal account, particularly to the more volatilecapital flows,
needs to be carefully orches-trated to match the capacity of
countries tomanage risk (World Bank 1999a; Stiglitz andBhattacharya
1999). Other important policiesmust focus on improving corporate
gover-nance, increasing transparency, and buildingsupportive
institutions.
Socially sensitive crisis management. Mac-roeconomic policy
responses to crises need tobe designed to minimize the social costs
andavoid large declines in aggregate demand andemployment (World
Bank 1999a; Lustig1999). Monetary policy should always avoid
high inflation as well as excessive increases ininterest rates,
both of which worsen any con-traction in aggregate demand. Policy
responsesaimed at reducing the social impact of crisesshould make
fiscal policy countercyclical inorder to reduce the extent of
contraction.However, developing countries typically haveprocyclical
fiscal policies that tend to aggra-vate the impact of downturns
(Easterly, Islam,and Stiglitz 1999). This phenomenon is theresult
of the high sensitivity of tax receipts tochanges in incomes,
underdeveloped domes-tic financial markets, limited access to
foreigncapital markets, and the risk of losing inves-tor
confidence. These factors make pursuingcountercyclical fiscal
policies difficult. Estab-lishing effective countercyclical fiscal
policiesrequires that public finances be managed wellduring good
times, so that there is room forexpansionary policies during
negative shocks.The adequate well-institutionalized use of
sta-bilization funds may also be helpful (Lustig1999). But even
East Asian countries that hadresponsible fiscal policies before the
crisis havefound it difficult to achieve the looser
fiscalobjectives.
Fiscal adjustments should also protect theexpenditures that are
most important for thepoor, such as employment and human
devel-opment programs and targeted subsidies.Where crises result in
high unemployment, thefiscal stimulus needs to be directed to
labor-intensive activities.
Managing volatility. In the long run de-veloping countries stand
to make gains ingrowth and to reduce poverty through opentrade
policies and integration into the worldeconomy. But external
shocks, such as capitalflow reversals and collapses in
commodityprices, may cause temporary increases in pov-erty that are
difficult to reverse. Developingcountries must develop the capacity
to man-age increased external and internal volatilitythrough better
economic management, morerobust institutions for managing risks
(suchas banks), and improved safety nets.
Safety nets. Before a crisis, safety nets canspur productivity
and growth by providing the
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67
insurance necessary for households to makerisky choices with
higher potential returns.Safety nets also help ensure that crises
do nothalt development. They help maintain essen-tial household
investments in education andhealth and eliminate the need for the
poor todivest themselves of physical capital. Settingup safety nets
during times of economic growthmay be the only effective way to
protect thepoor during crises (Ferreira, Prennushi, andRavallion
1999). The need for redistributioninevitably increases during
crises, even if mostpeople’s incomes fall. Although the newly
poorgenerate most of the increase in need, policiesneed not
distinguish between the old and newpoor.
As a response to a temporary shock, in-creases in spending on
social safety nets areideally financed over time, both past and
fu-ture. Despite this logic (or indeed, because ofit) countries
usually have to adopt policies withthe lowest budgetary costs.
Targeting benefitsis one desirable means of keeping costs
low.Self-selection mechanisms such as public worksare an important
means of reducing the bud-getary costs of redistributive policies
and ofestablishing institutions to deliver transfers.Establishing
well-functioning institutions maybe one of the largest setup costs
countries in-cur in response to deep crises. Ideally, ofcourse,
such investments precede a crisis. Re-cent international experience
confirms thatopen and transparent institutions operating ina
noncorrupt way are as important to the es-tablishment of safety
nets as they are to otherareas of public action.
The possibility of making a guarantee oflow-wage work on
community-initiatedprojects the central element of a safety net
maybe limited. If there is an institutional basis forsignificantly
expanding workfare programs,with central and local agencies
operating in atransparent and noncorrupt fashion, then theseschemes
could play a significant role in allevi-ating poverty. The
contribution of publicworks to poverty reduction tends to be
largerin countries such as Korea, where the socialcosts of crises
have primarily taken the form
E X T E R N A L S H O C K S , F I N A N C I A L C R I S E S , A
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of high unemployment. Public works are moreeffective at reducing
poverty in these coun-tries because the opportunity costs of
partici-pating in public works projects are lower forthe jobless
than for the working poor. Publicworks are an important and useful
option forreducing poverty during crises, especially indeveloping
countries in need of infrastructureinvestments. However, they are
best imple-mented alongside other programs for both theable-bodied
population and those unable towork.
Notes1. Easterly and others (1993); Lutz (1994);
Mendoza (1994); Hausmann and Gavin (1995);Spatafora and Warner
(1995); Deaton and Miller(1995); Collier and Gunning (1996);
Guillaumont,Jeanneney, and Brun (1999); Lundberg and Squire(1999).
The evidence concerns GDP and output growthand does not account for
the direct real income growththat results from increased purchasing
power on in-ternational markets.
2. Deaton and Miller (1995) suggest that in coun-tries that are
marginal producers of commodities,where labor accounts for a
significant share of costs,poverty itself may explain why real
commodity pricesdo not increase in the long run. These prices
cannotrise as long as there are unlimited supplies of labor atthe
subsistence wage. Long-term marginal costs areset by poverty in
tropical countries, and commoditytrade cannot contribute to
reducing it. Incentives fortechnical progress are weak, and even
when progressoccurs it tends to make prices fall while real
wagesremain at the subsistence level.
3. The headcount index is the proportion of in-dividuals in the
population whose income or consump-tion expenditures fall below the
poverty line.
4. The elasticity for other measures of poverty,such as the
poverty gap, are usually higher. See Liptonand Ravallion
(1995).
5. For a lower-end Gini index of 0.25, the elas-ticity would be
–3.3. It is –1.82 for a higher index of0.59 (Ravallion 1997).
6. Aizenman and Marion (1999) find similar re-sults.
7. This result holds under risk neutrality, but italso requires
some degree of imperfect competition(Caballero 1991).
8. The authors also find that foreign aid and goodpolicies can
offset this vulnerability.
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G L O B A L E C O N O M I C P R O S P E C T S
9. This finding is contrary to earlier findings byMcBean (1966)
that export instability has no effecton growth.
10. The asymmetry notion is also supported byfindings about the
relationship between the headcountpoverty index and mean country
income (Ravallion1997). More generally the poverty headcount
will,for a given absolute decrease in income, increase morefor a
poor than for a wealthy country (Milanovic1998).
11. Poverty figures for the rural areas are notavailable for
Korea.
12. The figures used for 1997 are estimates basedon the
declining poverty trends before the crisis.
13. Rural areas gained if they were not primarilyrice producing
and were not affected by drought (pricesremained low in these areas
until August 1998). Someareas also had natural disasters during the
crisis. Thedrought of 1997–98 was not as bad on Java as hadbeen
feared, but it did hit hard in the Eastern Islands,on the west
coast of Sumatra, and in parts of Sulawesi.East Kalimantan suffered
an ecological disaster whenthe drought interacted with
wildfires.
14. The measured Gini coefficients are eitherbased on
consumption expenditures or incomes. Inthe latter case they also
may be biased, as they donot reflect adequately all incomes and
changes of as-set values.
15. This result holds true even in industrial coun-tries. See
Farber (1993), and Layard, Nickell, andJackman (1994).
16. There was a shift from rural nonagriculturalto agricultural
jobs. Rural employment increased from56.05 to 57.37 million, while
agricultural employmentincreased from 34.8 to 39. 4 million.
17. Among the crisis-hit countries, Korea is theonly one that
had an unemployment insurance scheme,and had extended its potential
coverage.
18. Budgetary allocations to support the unem-ployed in Korea
were to double in April 1999 to in-crease the program’s coverage of
the poor.
19. The savings response in Korea and Malay-sia, which have
higher incomes than the other crisis-affected countries, may
reflect greater wealth effectsfrom the crisis.
20. The average enrollment rate for the 13–19age group was
around 60 percent in 1997.
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